chapter5/9 synthetic positions

Synthetic Positions

Options can be used to synthesize a long or short position in an underlying asset.

For example, simultaneously purchasing a call and selling a put with the same strike price and same expiration has the effect of being long the stock. Gains in the stock result in the call rising in price and the put falling in price, both positions gain in value as the stock rises.

A short position in a stock can be synthesized by purchasing a put and selling a call with the same strike and expiration.

Characteristics of a synthetic position:

• no ownership of the underlying asset
• no dividend can be collected, nor is one paid for a synthetic short
• no voting rights
• minimal cash is required, since the capital required to purchase one leg is offset by the proceeds from selling the other
• the position will expire
• it is possible to be assigned on the short leg, and the synthetic position holder may be forced to take possession of the stock, or be forced into a short position.

A trader entering a synthetic position should maintain enough capital to purchase, or hold short, the equivalent number of shares of the underlying asset in order to avoid a margin call.